Fed Preview: Powell Likely to Raise Rates by 25 Basis Points Against Crypto Market's Hope for Status Quo
Not raising rates now may make it more difficult later, some analysts say.
"The Fed needs to pause at a minimum, or the banking issues escalate," David Brickell, director of institutional sales at crypto liquidity network Paradigm, tweeted early Tuesday, suggesting that the world's most powerful central bank should prioritize banking sector stability over fighting inflation and keep interest rates unchanged on Wednesday.
That's been the sentiment in the crypto market ever since regulators took over Silicon Valley Bank on March 10. Since then, bitcoin (BTC) has rallied over 40%, partly on hopes that recent banks failures will force the Federal Reserve to abandon its rate hike cycle that rocked risky assets last year. The central bank has raised rates by 4.5 percentage points since March 2022.
Some observers, however, expect the Fed to disappoint popular expectations when it announces its rate policy on Wednesday.
"Our best guess is that the Fed hikes by 25 basis points given continued elevated inflation," Brian Rudick, senior strategist at crypto trading firm and liquidity provider GSR, told CoinDesk.
A rate hike of a quarter of a percentage point would lift the benchmark borrowing cost to the 4.75%-5% range and may see traders positioned for a pause trim their bullish exposure to bitcoin.
Marc Ostwald, chief economist and global strategist at ADM Investor Services International, said, "The Fed still views the banking sector as being well capitalized, and it will want to stress that the inflation battle is not won, and it remains too high, so a 25 bps hike seems very likely."
On Sunday, Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen said that the U.S. financial system remains resilient and the capital and liquidity positions of the banking system are strong.
Ostwald added that the Fed would find it more challenging to resume rate hikes if it pauses its tightening cycle now.
Trouble with a pause
Trades of liquidity-addicted risky assets might read the pause as a sign of an imminent early pivot toward rate cut and price in the same. That, in turn, would make it difficult for the Fed to resume rate hikes without shocking markets.
According to Michael Englund, principal director and chief economist at Action Economics, the Fed will follow the lead of the European Central Bank, which raised rates by 0.5 percentage point to 3% last week, sticking to its inflation fight despite the market chaos and fears of contagion from Credit Suisse's (CS) instability.
"Our forecast is for a 25 basis point hike, and we continue to assume 25 basis point hikes in May and June as well," Englund said in an email.
"If the Fed hikes rates, I think it would actually contribute to the notion that the Fed has the banking crisis under control, and may add to financial market stability, though bond prices would fall and yields would again price in a tighter policy path. The dollar would also get a lift," Englund added. (Bitcoin tends to move in the opposite direction of the dollar.)
A pause might put a question mark on the efficacy of the measures announced and trigger panic. Since the collapse of SVB, the Fed formed an emergency lending facility for banks and increased the frequency of its dollar swap lines from weekly to daily to shore up the global financial system.
Traders expecting the Fed to announce an end of quantitative tightening (sister of rate hikes) will also likely be disappointed.
"We wouldn’t see the Fed’s new programs to address SVB as having broader market implications, and we assume that the Fed will maintain its QT (quantitative tightening) process even if there is a one-off bounce in the size of the Fed balance sheet," Englund said.
The narrative that QT is about to end gripped the market last week after data showed the Fed's balance sheet swelled by $300 billion in the seven days to March 15.
According to GSR's Rudick, Powell is likely to do a balancing act by striking a dovish tone after raising rates, offering a lifeline to risky assets.
"Powell’s tone is somewhat dependent on the policy action. He will take a more hawkish [pro-tightening] tone to keep inflation expectations in check should the Fed pause or take a more dovish tone should the Fed hike," Rudick said.
Traders will also pay attention to the bank's quarterly economic projections.
ADMISI's Ostwald expects the dot plot – a graphical representation of policymakers' interest-rate projections – to signal a peak of around 5.37% from 5.125% in December. Ostwald also expects the Fed to raise growth and inflation forecast and revise estimates for the lower jobless rate.
An upward revision of the peak rate forecast might bring some selling pressure to risky assets, considering the market's expectation for the same has recently declined to 4.8%.
11:43 UTC: Attributes GSR's quotes to the firm's senior strategist Brian Rudick. The previous version attributed GSR's quotes to its founder Richard Rosenblum.
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